Can the Central Bank of Russia Rescue the Economy as Oil Prices Plummet?

Russia’s oil and gas sector is having a bad year. The industry, which provides almost half of the revenue in Russia’s budget, was hit hard by Western sanctions resulting from the Ukrainian conflict. Then, oil prices fell by almost 20% between June and mid-October 2014.

Both events are likely to cause oil production to stagnate in the near future. Western sanctions imposed against Russia limit access by key oil companies to international capital markets, and falling oil prices undermine the companies’ own revenue base.

Should the output of Russia’s energy sector stop growing and commodity prices continue to decline, many observers are wondering how the Russian government is going to balance its budget. Deutsche Bank estimates that the oil price that allows the Russian government to balance its commodity-dependent budget is US$100 a barrel. Currently the Brent spot oil price is hovering around US$85-$90 a barrel.

Could this mean that the Russian government is going to increase the tax burden on oil companies and/or reduce expenditures, as governments usually do in the time of crisis? The Russian government may be able to delay this decision for a while, thanks to the monetary policy pursued by the Central Bank of Russia (CBR).

Russia’s floating currency

The CBR allows the country’s currency to float and manages its decline by shifting the currency corridor (a band within which the rouble trades relative to a dollar-euro basket). Should the currency cross the corridor, the bank intervenes and supports it. Since the beginning of the year the CBR has had to shift the corridor several times, resulting in modest losses of the foreign exchange (FX) reserves.

Between January and October 2014, the CBR spent US$60 billion to support the currency compared to 2008-2009, when oil prices fell by almost 40% compared to the previous year. This cost the CBR almost US$200 billion to support the rouble.

Fortunately, the weaker rouble, which lost almost 24% of its nominal value compared to the US dollar between January and mid-October, compensated for lower dollar-dominated oil revenues for the budget. As a result of CBR’s policy, the budget ran a surplus of 1.5 billion roubles for the first eight months of 2014. In September, despite the sharply falling oil prices, the budget surplus was at US$3.6 billion. With the CBR’s commitment to the free floating rouble, the Ministry of Finance can balance the budget at lower oil prices.

Though CBR policy helps balance the budget now, this is a survival maneuver and it will only buy the government so much time. By averting the burden of heavier taxation on businesses, the Russian authorities put pressure on household budgets, whose purchasing power is diminishing due to the weaker rouble and rising inflation fueled by the depreciating local currency.

At some point the Russian government has to decide to either increase taxes on businesses or continue to impoverish its people. The later could undermine public support for the current leadership — especially President Putin, who has been credited with the country’s rising standard of living over the past decade.